Similar presentations

3
Examine the simple money multiplier approach to money supply determination Examine the meaning of financial innovation. Examine implications for the monetary system and the transmission mechanism Implications for monetary control Examine the counterparts approach to money supply determination

4
The money multiplier Mechanical link between base money and broad (bank) money Treats base money as exogenous By assuming that the ratio of currency to deposits and reserves to deposits is constant, the link between base money and broad money is the multiplier.

7
Principal causes of financial innovation High variable and unpredictable inflation leading to high variable and unpredictable rates of interest Restrictive regulations tending to discriminate against certain kinds of Financial Institutions Development of technology

8
Three strands of financial innovation Switch from asset to liability management development of variable rate lending cash management technology

20
US experiment In October 1979 the Fed switched from controlling Fed funds rate to controlling non-borrowed reserves to target M1 Bankers and professional economists argued that the shift to a form of base control would cause greater fluctuations in interest rates

21
Inflation expectations and long-term bond yields Bond rates did not reflect a fall in inflation expectations Financial innovation - development of NOW accounts Required reserves based on lagged accounting basis

29
Volatility Clearly (13) > (7) Monetarists argued that excessive volatility led to a risk premium being priced into bond rates. A temporary rise in monetary growth could have led to a rise in long term rates because people confuse a short term increase with a long term increase.

30
Further Distortions The fluctuations in short rates gave additional impetus to the development of new financial instruments NOW, Super NOW, Money Market Mutual Funds etc. Distortion of the money supply figures led to the abandonment of the target in 1982.

32
Conclusion Experiment with monetary targeting was not an unqualified success Financial innovation and financial sector deregulation had blurred the boundaries between money and non-money and distorted the established links between broad money and other economic variables Inflation targeting has an implicit monetary control